12 End of Year Tax Saving Tips

end of year tax saving tips

As we approach the close of 2019, we share our list of 12 end of year tax saving tips. Now is a great time to review your finances. You can make several smart and simple tax moves that can help lower your tax bill and increase your tax refund.

The Tax Cuts and Jobs Act of 2017 made sweeping changes in the tax code that affected many families and small business owners. If the previous tax season caught you off-guard, now you have a chance to redeem yourself.

Whether you file taxes yourself or hire a CPA, it is always better to be proactive. If you are expecting a large tax bill or your financials have changed substantially since last year, talk to your CPA. Start the conversation. Don’t wait until the last moment. Being ahead of the curve will help you make well-informed decisions without the stress of tax deadlines.

1. Know your tax bracket

The first step of mastering your taxes is knowing your tax bracket. 2019 is the second year after the TCJA took effect. One of the most significant changes in the tax code was introducing new tax brackets.

Here are the tax bracket and rates for 2019.

End of Year Tax Tips

2. Decide to itemize or use a standard deduction

Another big change in the tax law was the increase in the standard deduction. The standard deduction is a specific dollar amount that allows you to reduce your taxable income. As a result of this change, nearly 90% of all tax filers will take the standard deduction instead of itemizing. It makes the process a lot simpler for many Americans. Here are the values for 2019:

End of Year Tax Tips

3. Maximize your retirement contributions

Most contributions to qualified retirement plans are tax-deductible and will lower your tax bill.

  • For employees – 401k, 403b, 457 and TSP. The maximum contribution to qualified employee retirement plans for 2019 is $19,000. If you are at the age of 50 or older, you can contribute an additional $6,000.
  • For business owners – SEP IRA, Solo 401k and Defined Benefit Plan. Business owners can contribute to SEP IRA, Solo 401k, and Defined Benefits plans to maximize your retirement savings and lower your tax bill. The maximum contribution to SEP-IRA and Solo 401k in 2019 is $56,000 or $62,000 if you are 50 and older.

If you own SEP IRA, you can contribute up 25% of your business wages.

In a solo 401k plan, you can contribute as both an employee and an employer. The employee contribution is subject to a $19,000 limit plus a $6,000 catch-up. The employer match is limited to 25% of your compensation for the maximum $37,000. Depending on how you pay yourself, sometimes solo 401k can allow you for more savings than SEP IRA.

Defined Benefit Plans is an option for high-income earners who want to save more aggressively for retirement above the SEP-IRA and 401k limits. The DB plan uses actuary rules to calculate your annual contribution limits based on your age and compensation. All contributions to your defined benefit plan are tax-deductible, and the earnings grow tax-free.

4. Convert to Roth IRA

The process of transferring assets from a Traditional IRA or 401k plan to a Roth IRA is known as Roth Conversion. It allows you to switch from tax-deferred to tax-exempt retirement savings. You can learn more about the benefits of Roth IRA here.

The conversion amount is taxable for income purposes. The good news is that even though you will pay higher taxes in the current year, it may save you a lot more money in the long run.

While individual circumstances may vary, Roth Conversion could be very effective in a year with low or no income. Talk to your accountant or financial advisor. Ask if Roth conversion makes sense for you.

5. Contribute to a 529 plan

The 529 plan is a tax-advantaged state-sponsored investment plan, which allows parents to save for their children’s future college expenses. 529 plan works similarly to the Roth IRA. You make post-tax contributions. Your investment earnings grow free from federal and state income tax if you use them to pay for qualified educational expenses. Compared to a regular brokerage account, the 529 plan has a distinct tax advantage as you will never pay taxes on your dividends and capital gains.

Over 30 states offer a full or partial tax deduction or a credit on your 529 contributions. You can find the full list here. If you live in any of these states, your 529 contributions can lower your state tax bill significantly.

6. Make a donation

Donations to charities, churches, and various non-profit organizations are tax-deductible. You can support your favorite cause by giving back and lower your tax bill at the same time.

However, due to the changes in the new tax code, donations are tax-deductible only when you itemize your tax return. If you make small contributions throughout the year, you probably will be better off taking the standard deduction.

If itemizing your taxes is crucial for you, then you might want to consolidate your donations in one calendar year. So, instead of making multiple charitable contributions over the years, you can give one large donation every few years.

7. Sell losing investments

The process of selling losing investments to reduce your tax liability is known as tax-loss harvesting. It works for capital assets held outside retirement accounts (such as 401k, Traditional IRA, and Roth IRA). Capital assets may include real estate, cars, gold, stocks, bonds, and any investment property, not for personal use.

The IRS allows you to use capital losses to offset capital gains. If your capital losses are higher than your capital gains, you can deduct the difference as a loss on your tax return. This loss is limited to $3,000 per year or $1,500 if married and filing a separate return.

8. Prioritize long-term over short-term capital gains

Another way to lower your tax bill when selling assets is to prioritize long-term over short-term capital gains. The current tax code benefits investors who keep their assets for more than one calendar year. Long-term investors receive a preferential tax rate on their gains. While investors with short-term capital gains will pay taxes at their ordinary income tax level

Here are the long-term capital gain tax brackets for 2019:

End of Year Tax Tips

High-income earners will also pay an additional 3.8% net investment income tax.

9. Take advantage of FSA and HSA

With healthcare costs always on the rise, you can use a Flexible Spending Account (FSA) or a Health Savings Account (HSA) to cover your medical bills and lower your tax bill.

Flexible Spending Account (FSA)

A Flexible Spending Account (FSA) is a tax-advantaged savings account offered through your employer. The FSA allows you to save pre-tax dollars to cover medical and dental expenses for yourself and your dependents. The maximum contribution for 2019 is $2,700 per person. If you are married, your spouse can save another $2,700 for a total of $5,400 per family. Typically, you should use your FSA savings by the end of the calendar year. However, the IRS allows you to carry over up to $500 balance into the new year.

Dependent Care FSA (CSFSA)

A Dependent Care FSA (CSFSA) is a pre-tax benefit account that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare. It’s an easy way to reduce your tax bill while taking care of your children and loved ones while you continue to work. The maximum contribution limit for 2019 for an individual who is married but filing separately is $2,500. For married couples filing jointly or single parents filing as head of household, the limit is $5,000.

Health Savings Account (HSA)

A Health Savings Account (HSA) is an investment account for individuals under a High Deductible Health Plan (HDHP) that allows you to save money on a pre-tax basis to pay for eligible medical expenses.The qualified High Deductible Plan typically covers only preventive services before the deductible. To qualify for the HSA, the HDHP should have a minimum deductible of $1,350 for an individual and $2,700 for a family. Additionally, your HDHP must have an out-of-pocket maximum of up to $6,750 for one-person coverage or $13,500 for family.

The maximum contributions in HSA for 2019, are $3,500 for self-only coverage and $7,000 for a family. HSA participants who are 55 or older can contribute an additional $1,000 as a catch-up contribution. Unlike the FSA, the HSA doesn’t have a spending limit, and you can carry over the savings in the next calendar year.

Keep in mind that the HSA has three distinct tax advantages. First, all HSA contributions are tax-deductible and will lower your tax bill. Second, you will not pay taxes on dividends, interest, and capital gains. Third, if you use the account for eligible expenses, you don’t pay taxes on those withdrawals either.

10. Defer income

Deferring income from this calendar year into the next year will allow you to delay some of the income taxes coming with it. Even though it’s not always possible to defer wages, you might be able to postpone a large bonus, royalty, or onetime payment. Remember, it only makes sense to defer income if you expect to be in a lower tax bracket next year.

Reversely, if you are expecting to be in a higher tax bracket tax year next year, you may consider taking as much income as possible in this tax year.

11. Buy Municipal Bonds

Municipal bonds are issued by local governments, school districts, and authorities to fund local projects that will benefit the general public. The interest income from most municipal bonds is tax-free. Investors in these bonds are exempt from federal income tax. If you buy municipal bonds issued in the same state where you live, you will be exempt from state taxes as well.

12. Take advantage of the 199A Deduction for Business Owners

If you are a business owner or have a side business, you might be able to use the 20% deduction on qualified business income. The TCJA established a new tax deduction for small business owners of pass-through entities like LLCs, Partnerships, S-Corps, and sole-proprietors. While the spirit of the law is to support small business owners, the rules of using this deduction are quite complicated and restrictive. For more information, you can check the IRS page. In summary, qualified business income must be related to conducting business or trade within the United States or Puerto Rico. The tax code also separates the business entities by industry – Qualified trades or businesses and Specified service trades or businesses.

Qualified versus specified service trade

Specified service businesses include the following trades: Health (e.g., physicians, nurses, dentists, and other similar healthcare professionals), Law, Accounting, Actuarial science, Performing arts, Consulting, Athletics, and Financial Services. Qualified trades or businesses is everything else.

For “specified service business,” the deduction gets phased out between $315,000 and $415,000 for joint filers. For single filers, the phase-out range is $157,500 to $207,500.

The qualified trades and businesses are also subject to the same phaseout limits. However, if their income is above the threshold, the 199A deduction becomes the lesser of the 20% of qualified business income deduction or the greater of either 50 percent of the W-2 wages of the business, or the sum of 25% of the W-2 wages of the business and 2.5% of the unadjusted basis immediately after acquisition of all qualified property.

If this all sounds very complicated to you, it’s because it is complicated.Contact your accountant or tax adviser to see if you can take advantage of this deduction.

9 Smart Tax Saving Strategies for High Net Worth Individuals

9 Smart Tax Saving Strategies for High Net Worth Individuals

The Tax Cuts and Jobs Act (TCJA) voted by Congress in late 2017 introduced significant changes to the way individuals and businesses file their taxes. The key changes included the doubling of the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly, the elimination of personal exemptions, limiting the SALT deduction to $10,000, limiting the home mortgage interest deduction to loans of up to $750,000 versus $1,000,000 as well as comprehensive changes to itemized deductions and Alternative Minimum Tax.

Many high net worth individuals and families, especially from high tax states like California, New York, and New Jersey, will see substantial changes in their tax returns. The real impact won’t be completely revealed until the first tax filing in 2019. Many areas remain ambiguous and will require further clarification by the IRS.

Most strategies discussed in this article were popular even before the TCJA. However, their use will vary significantly from person to person.  I strongly encourage you to speak with your accountant, tax advisor or investment advisor to better address your concerns.

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1. Home mortgage deduction

While a mortgage tax deduction is rarely the primary reason to buy a home, many new home buyers will have to be mindful of the new tax rule limiting mortgage deductions to loans of up to $750,000. The interest on second home mortgages is no longer tax deductible.  The interest on Home Equity Loans or HELOCs could be tax deductible in some instances where proceeds are utilized to acquire or improve a property

2. Get Incorporated

If you own a business, you may qualify for a 20 percent deduction for qualified business income. This break is available to pass-through entities, including S-corporations and limited liability companies. In general, to qualify for the full deduction, your taxable income must be below $157,500 if you’re single or $315,000 if you’re married and file jointly. Beyond those thresholds, the TJLA sets limits on what professions can qualify for this deduction. Entrepreneurs with service businesses — including doctors, attorneys, and financial advisors — may not be able to take advantage of the deduction if their income is too high.

Furthermore, if you own a second home, you may want to convert it to a rental and run it as a side business. This could allow you to use certain tax deductions that are otherwise not available.

Running your business from home is another way to deduct certain expenses (internet, rent, phone, etc.). In our digital age, technology makes it easy to reach out to potential customers and run a successful business out of your home office.

3. Charitable donations

All contributions to religious, educational or charitable organization approved by IRS are tax deductible. The annual limit is 50% of your AGI (aggregate gross income) for most donations and 30% of AGI for appreciated assets.

While most often people choose to give money, you can also donate household items, clothes, cars, airline miles, investments, and real estate. The fair value of the donated items decreases your taxable income and therefore will reduce the amount of taxes due to IRS.

The TCJA made the tax planning for donations a little bit trickier. The new tax rules raised the standard deduction to $12,000 for singles and $24,000 for married couples filing jointly. In effect, the rule will reduce the number of people who are itemizing their taxes and make charitable donations a less attractive tax strategy.

For philanthropic high net worth individuals making charitable donations could require a little more planning to achieve the highest possible tax benefit. One viable strategy is to consolidate annual contributions into a single large payment. This strategy will ensure that your donations will go above the yearly standard deduction threshold.

Another approach is to donate appreciated investments, including stocks and real estate. This strategy allows philanthropic investors to avoid paying significant capital gain tax on low-cost basis investments. To learn more about the benefits of charitable donations, check out my prior post here.

4. Gifts

The TCJA doubled the gift and estate tax exemption to almost $11.18 million per person and $22.36 per married couple. Furthermore, you can give up to $15,000 to any number of people every year without any tax implications. Amounts over $15,000 are subject to the combined gift and estate tax exemption of $11 million.  You can give your child or any person within the annual limits without creating create any tax implications.

Making a gift will not reduce your current year taxes. However, making gifts of appreciated assets with a lower cost basis can be a way to manage your future tax payments and pass on the tax bill to family members who pay a lower tax rate.

5. 529 Plans

The TCJA of 2017 expanded the use of 529 plans to cover qualifying expenses for private, public, and religious kindergarten through 12th grade. Previously parents and grandparents could only use 529 funds for qualified college expenses.

The use of 529 plans is one of the best examples of how gifts can minimize your future tax burden. Parents and grandparents can contribute up to $15,000 annually per person, $30,000 per married couple into their child college education fund. The plan even allows a one–time lump sum payment of $75,000 (5 years x $15,000).

Parents can choose to invest their contributions through a variety of investment vehicles.  While 529 contributions are not tax deductible on a federal level, many states like New York, Massachusetts, Illinois, etc. allow for state tax deductions for up to a certain amount. The 529 investments grow tax-free. Withdrawals are also tax-free when used to pay cover qualified college and educational expenses. 

6. 401k Contributions

One of the most popular tax deductions is the tax-deferred contribution to 401k and 403b plans. In 2018 the allowed maximum contribution per person is $18,500 plus an additional $6,000 catch-up for investors at age 50 and older. Also, your employer can contribute up to $36,500 for a maximum annual contribution of $55,000 or $61,000 if you are older than 50.

The contributions to your retirement plan are tax deductible. They decrease your taxable income if you use itemized deductions on your tax filing form. Not only that, the investments in your 401k portfolio grow tax-free. You will owe taxes upon withdrawal at your current tax rate at that time.

7. Roth conversion

Roth IRA is a great investment vehicle. Investors can contribute up to $5,500 per year. All contributions to the account are after-tax.  The investments in the Roth IRA can grow tax-free. And the withdrawals will be tax exempt if held till retirement. IRS has limited the direct contributions to individuals making up to $120,000 per year with a phase-out at $135,000. Married couples can make contributions if their income is up to $189,000 per year with a phase-out at $199,000.

Fortunately, recent IRS rulings made it possible for investors who do not qualify for direct contributions, to use a two-step process known as backdoor Roth and take advantage of the long-term Roth IRA benefits. Learn more about Roth IRA in our previous post here. 

8. Health Spending Account

A health savings account (HSA) is a tax-exempt saving account available to taxpayers who are enrolled in a high-deductible health plan (HDHP) The funds contributed to this account are tax deductible. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year over year if not spent. HSA owners can use the funds to pay for qualified medical expenses at any time without tax liability or penalty. The annual contribution limits for 2018 are $3,450 per person, $6,900 per family and an additional $1,000 if 55 or older. The owner of HSA can invest the funds similar to the IRA account.

In effect, HSAs have a triple tax benefit. All contributions are tax deductible. Investments grow tax-free and. HSA owners can make tax-free withdrawals for qualified medical expenses.

9. Municipal bonds

Old fashioned municipal bonds continue to be an attractive investment choice of high net worth individuals. The interest income from municipal bonds is still tax exempt on a federal level. When the bondholders reside in the same state as the bond issuer, they can be exempted from state income taxes as well.

Final words

If you have any questions about your existing investment portfolio, reach out to me at stoyan@babylonwealth.com or +925-448-9880.

You can also visit our Insights page where you can find helpful articles and resources on how to make better financial and investment decisions.

About the author:

Stoyan Panayotov, CFA is the founder and CEO of Babylon Wealth Management, a fee-only investment advisory firm based in Walnut Creek, CA. Babylon Wealth Management offers personalized wealth management and financial planning services to individuals and families.  To learn more visit our Private Client Services page here.

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Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is the sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation, and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,

14 Effective ways to take control of your taxes

In this blog post, I will go over several popular and some not so obvious tax deductions and strategies that can help you decrease your annual tax burden. Let’s be honest.  Nobody wants to pay taxes. However, taxes are necessary to pay for pensions, social services, Medicaid, roads, police, law enforcement and so on. Most people will earn a higher income and grow their investments portfolios as their approach retirement. Thus they will gradually move to higher tax brackets and face a higher tax bill at the end of the year. IRS provides many tax deductions and breaks that can help you manage your tax burden. Taking advantage of these tax rules can help you reduce your current or future your tax bill.

These are general rules. I realize that we all face different circumstances. Use them as a broad guideline. Your particular situation may require a second opinion by an accountant, a tax lawyer or an investment advisor.

Learn more about our Private Client Services

 

1. Primary residence mortgage deductions

Buying a first home is a big decision. Your new neighborhood, school district, nearby services are all critical factors you need to consider before making your choice. If you own a primary residence (sorry, a vacation home in Hawaii doesn’t count), you can deduct the interest on your mortgage loan from your taxable income for the year. Your property taxes are also deductible. These incentives are provided by the Federal and state governments to encourage more families to buy their home.

There are two additional benefits of having a mortgage and being a responsible borrower. First, your credit score will increase. Making regular payments on your mortgage (or any loan) improves your credit history, increases your FICO score and boosts your creditworthiness. Your ability to take future loans at a lower rate will significantly improve. Second, your personal equity (wealth) will increase as you pay off your mortgage loan. Your personal equity is a measure of assets minus your liabilities.  Higher equity will boost your credit score. It is also a significant factor in your retirement planning.

Buying a home and applying for a mortgage is a long and tedious process. It requires a lot of legwork and documentation. After the financial crisis in 2008 banks became a lot stricter in their requirements for providing mortgage loans to first buyers. Nevertheless, mortgage interest on a primary residence is one of the biggest tax breaks available to taxpayers.

 

2. Home office deductions

Owning a home versus renting is a dilemma for many young professionals. While paying rent offers flexibility and lower monthly cash payments it doesn’t allow you to deduct your rent from your taxes. Rent is usually the highest expense in your monthly budget. It makes up between 25% and 35% of your total income. The only time you can apply your rent as a tax deduction is if you have a home office.

A home office is a dedicated space in your apartment or house to use for the sole purpose of conduction your private business. It’s usually a separate room, basement or attic designated for your business purposes.

The portion of your office to the total size of your home can be deductible for business purposes. If your office takes 20% of your home, you can deduct 20% of the rent and utility bills for business expense purposes.

 

3. Charitable donations

Monetary and non-monetary contributions to religious, educational or charitable organization approved by IRS are tax deductible. The annual limit is 50% of your AGI (aggregate gross income) for most donations and 30% of AGI for appreciated assets.

Most often people choose to give money. However, you can also donate household items, clothes, cars, and airline miles. The fair value of the donated items decreases your taxable income and therefore will reduce the amount of taxes due to IRS.

Another alternative is giving appreciated assets including stocks and real estate. This is one of the best ways to avoid paying significant capital gain tax on low-cost investments. For one, you are supporting a noble cause. Second, you are not paying taxes for the difference between the market value and purchase cost of your stock. Also, the fair market value of the stock at the time of donation will reduce your taxable income, subject to 30% of AGI rule. If you were to sell your appreciated assets and donate the proceeds to your charity of choice, you would have to pay a capital gain tax on the difference between market value and acquisition cost at the time of sale. However, if you donate the investments directly to the charity, you avoid paying the tax and use the market value of the investment to reduce your taxable income.

 

4. Gifts

Making a gift is not a standard tax deduction. However, making gifts can be a way to manage your future tax payments and pass on the tax bill to family members who pay a lower tax rate. You can give up to $14,000 to any number of people every year without any tax implications. Amounts over $14,000 are subject to the combined gift and estate tax exemption of $5.49 million for 2017.  You can give your child or any person within the annual limits without creating create any tax implications.

Another great opportunity is giving appreciated assets as a gift. If you want to give your children or grandchildren a gift, it is always wise to consider between giving them cash or an appreciated asset directly.  Giving appreciated assets to family members who pay a lower tax rate doesn’t create an immediate tax event. It transfers the tax burden from the higher rate tax giver to the lower tax rate receiver.

 

5. 529 Plans

One of the best examples of how gifts can minimize future tax payments is the 529 college tuition plan. Parents and grandparents can contribute up to $14,000 annually per person, $28,000 per married couple into their child college education fund. The plan even allows a one–time lump sum payment of $70,000 (5 years x $14,000).

529 contributions are not tax deductible on a federal level. However, many states like New York, Massachusetts, Illinois, etc. allow for state tax deductions up to a certain amount. The plan allows your contributions (gifts) to grow tax-free. Withdrawals are also tax-free when using the money to pay qualified college expenses.

 

6. Tax-deferred contributions to 401k, 403b, and IRA

One of my favorite tax deductions is the tax-deferred contribution to 401k and 403b plans. In 2017 the allowed maximum contribution per person is $18,000 plus an additional $6,000 catch-up for investors at age 50 and older. In addition to that, your employer can contribute up to $36,000 for a total annual contribution of $54,000 or $60,000 if you are older than 50.

Most companies offer a matching contribution of 5%-6% of your salary and dollar limit of $4,000 – $5,000. At a very minimum, you should contribute enough to take advantage of your company matching plan. However, I strongly recommend you to set aside the entire allowed annual contribution.

The contributions to your retirement plan are tax deductible. They decrease your taxable income if you use itemized deductions on your tax filing form. Not only that, the investments in your 401k portfolio grow tax-free. You will owe taxes upon withdrawal at your current tax rate at that time.

If you invest $18,000 for 30 years, a total of $540,000 contributions, your portfolio can potentially rise to $1.5m in 30 years at 6% growth rate. You will benefit from the accumulative return on your assets year after year.  Your investments will grow depending on your risk tolerance and asset allocation. You will be able to withdraw your money at once or periodically when you retire.

 

7. Commuter benefits

You are allowed to use tax-free dollars to pay for transit commuting and parking costs through your employer-sponsored program.  For 2017, you can save up to $255 per month per person for transit expenses and up to $255 per month for qualified parking. Qualified parking is defined as parking at or near an employer’s worksite, or at a facility from which employee commutes via transit, vanpool or carpool. You can receive both the transit and parking benefits.

If you regularly commute to work by a bike you are eligible for $20 of tax-free reimbursement per month.

By maximizing the monthly limit for both transportation and parking expenses, your annual cost will be $6,120 ($255*2*12). If you are in the 28% tax bracket, by using the commuter benefits program, you will save $1,714 per year. Your total out of pocket expenses will be $ 4,406 annually and $367 per month.

 

8. Employer-sponsored health insurance premiums

The medical insurance plan sponsored by your employer offers discounted premiums for one or several health plans.  If you are self-employed and not eligible for an employer-sponsored health plan through your spouse or domestic partner, you may be able to deduct your health insurance premiums.  With the rising costs of health care having a health insurance is almost mandatory.  Employer-sponsored health insurance premiums can average between $2,000 for a single person and 5,000 for a family per year. At a 28% tax rate, this is equal to savings between $560 and $1,400. Apart from the tax savings, having a health insurance allows you to have medical services at discounted prices, previously negotiated by your health insurance company. In the case of emergency, the benefits can significantly outweigh the cost of your insurance premium.

 

9. Flexible Spending Account

Flexible Spending Account (FSA) is a special tax-advantaged account where you put money aside to pay for certain out-of-pocket health care costs. You don’t pay taxes on these contributions. This means you will save an amount equal to the taxes you would have paid on the money you set aside. The annual limit per person is $2,600. For a married couple, the amount can double to $5,200. The money in this account can be used for copayments, new glasses, prescription medications and other medical and dental expenses not covered by your insurance.  FSA accounts are arranged and managed by your employer and subtracted from your paycheck.

Let’s assume that you are contributing the full amount of $2,600 per year and your tax rate is 28%. You effectively save $728 from taxes, $2,550 * 28%. Your actual out-of-pocket expense is $1,872.

One drawback of the FSA is that you must use the entire amount in the same tax year. Otherwise, you can lose your savings. Some employers may allow up to 2.5 months of grace period or $500 of rollover in the next year. With that in mind, if you plan for significant medical expenses, medication purchases or surgery, the FSA is a great way to make some savings.

 

10. Health Spending Account

A health savings account (HSA) is a tax-exempt medical savings account available to taxpayers who are enrolled in a high-deductible health plan (HDHP) The funds contributed to this account are not subject to federal income tax at the time of deposit. Unlike a flexible spending account (FSA), HSA funds roll over and accumulate year over year if not spent. HSA owners can use the funds to pay for qualified medical expenses at any time without tax liability or penalty. The annual contribution limits are $3,350 per person, $6,750 per family and an additional $1,000 if 55 or older. The owner of HSA can invest the funds similarly to IRA account and withdraw without penalty when used for medical expenses.

 

11. Disability  insurance

Disability premiums are generally not deductible from your tax return. They are paid with after-tax dollars. Therefore, any proceeds received as a result of disability are tax-free. The only time your benefits are taxable is when your employer pays your disability insurance and does not include it in your gross income.


12. Life insurance

Life insurance premiums are typically not deductible from your tax return if you are using after-tax dollars. Therefore, any proceeds received by your beneficiaries are tax-free.

Life insurance benefits can be tax deductible under an employer-provided group term life insurance plan. In that case, the company pays fully or partially life insurance premiums for its employees.  In that scenario, amounts more than $50,000 paid by your employer will trigger a taxable income for the “economic value” of the coverage provided to you.

If you are the owner of your insurance policy, you should make sure your life insurance policy won’t have an impact on your estate’s tax liability. In order to avoid having your life insurance policy affecting your taxes, you can either transfer the policy to someone else or put it into a trust.

13. Student Loan interest

If you have student loans and you can deduct up to $2,500 of loan interest.  To use this deduction, you must earn up to $80,000 for a single person or $165,000 for a couple filing jointly. This rule includes you,  your spouse or a dependent. You must use the loan money for qualified education expenses such as tuition and fees, room and board, books, supplies, and equipment and other necessary expenses (such as transportation)

14. Accounting and Investment advice expenses

You may deduct your investment advisory fees associated with your taxable account on your tax return.  You can list them on Schedule A under the section “Job Expenses and Certain Miscellaneous Deductions.” Other expenditures in this category are unreimbursed employee expenses, tax preparation fees, safe deposit boxes and other qualifying expenses like professional dues, required uniforms, subscriptions to professional journals, safety equipment, tools, and supplies. They may also include the business use of part of your home and certain educational expenses. Investment advisory fees are a part of the miscellaneous deduction.  The entire category is tax deductible if they exceed 2% of your adjusted gross income for the amount in excess.

 

About the Author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing,  Image Copyright: www.123rf.com

10 Ways to reduce taxes in your investment portfolio

10 Ways to reduce taxes in your investment portfolio

Successful practices to help you lower taxes in your investment portfolio

A taxable investment account is any brokerage or trust account that does not come with tax benefits. Unlike Roth IRA and Tax-Deferred 401k plans, these accounts do not have many tax advantages. Your contributions to the account are in taxable dollars. This is money you earned from salary, royalties, the sale of property and so on. All gains, losses, dividends, interest and other income from any investments are subject to taxes at the current tax rates.  In this post, we will discuss several successful practices that can help you lower taxes in your investment portfolio

Why investors put money into taxable accounts? They provide flexibility and liquidity, which are not available by other retirement accounts. Money is readily accessible for emergencies and unforeseen expenses. Many credit institutions take these accounts as a liquid asset for loan applications.

Since investment accounts are taxable, their owners often look for ways to minimize the tax impact at the end of the year. Several practices can help you reduce your overall tax burden.

1. Buy and Hold

Taxable investment accounts are ideal for buy and hold investors who don’t plan to trade frequently. By doing that investors will minimize trading costs and harvest long-term capital gains when they decide to sell their investments. Long-term capital gains are taxable at a favorable rate of 0%, 15% or 20% plus 3.8% Medicare surcharge. In contrast, short-term gains for securities held less than a year are taxed at the higher ordinary income level.

Individuals and families often use investments accounts for supplemental income and source of liquidity. Those investors are usually susceptible to market volatility. Diversification is the best way to lower market risk. I strongly encourage investors to diversify their portfolios by investing in uncorrelated assets including mid-cap, small-cap, international stocks, bonds, and real assets.

2. Invest in Municipal Bonds

Most municipal bonds are exempt from taxes on their coupon payments. They are considered a safer investment with slightly higher risk than Treasury bonds but lower than comparable corporate bonds.

This tax exemption makes the municipal bond suitable investment for taxable accounts, especially for individuals in the high brackets category.

3. Invest in growth non-dividend paying stocks

Growth stocks that pay little or no dividend are also a great alternative for long-term buy and hold investors. Since the majority of the return from stocks will come from price appreciation, investors don’t need to worry about paying taxes on dividends. They will only have to pay taxes when selling the investments. 

4. Invest in MLPs

Managed Limited Partnerships have a complex legal and tax structure, which requires them to distribute 90% of their income to their partners. The majority of the distributions come in the form return on capital which is tax-deferred and deducted from the cost basis of the investments. Investors don’t owe taxes on the return on capital distributions until their cost basis becomes zero or decide to sell the MLP investment.

One caveat, MLPs require K-1 filing in each state where the company operates, which increases the tax filing cost for their owners.

 5. Invest in Index Funds and ETFs

Index funds and ETFs are passive investment vehicles. Typically they track a particular index or a benchmark. ETFs and index fund have a more tax efficient structure that makes them suitable for taxable accounts. Unlike them, most actively managed mutual funds frequently trade in and out of individual holdings causing them to release long-term and short-term capital gains to shareholders.

6. Avoid investments with a higher tax burden

While REITs, taxable bonds, commodities and actively managed mutual funds have their spot in the investment portfolio, they come with a higher tax burden.

The income from REITs, treasuries, corporate and international bonds is subject to the higher ordinary income tax, which can be up to 39.6% plus 3.8% Medicare surcharge

Commodities, particularly Gold are considered collectibles and taxed at a minimum of 28% for long-term gains.

Actively managed funds, as mentioned earlier, periodically release long-term and short-term capital gains to their shareholders, which automatically triggers additional taxes.

7. Make gifts

You can use up to $14,000 a year or $28,000 for a couple to give to any number of people you wish without tax consequences. You can make gifts of cash or appreciated investments from your investment account to family members at lower tax bracket than yours.

8. Donate 

You can make contributions in cash for up to 50% of your taxable income to your favorite charity. You can also donate appreciated stocks for up to 30% of AGI. Consequently, the value of your donation will reduce your income for the year. If you had a good year when you received a big bonus, sold a property or made substantial gains in the market, making donations will help you reduce your overall tax bill for the year.

9. Stepped up cost basis

At the current law, the assets in your investment account will be received by your heirs at the higher stepped-up basis, not at the original purchase price. If stocks are transferred as an inheritance directly (versus being sold and proceeds received in cash), they are not subject to taxes on any long-term or short-term capital gains. Your heirs will inherit the stocks at the new higher cost basis.  However, if your investments had lost value over time, you may wish to consider other ways to transfer your wealth. In this case, the stepped-up basis will be lower than you originally paid for and may trigger higher taxes in the future for your heirs.

10. Tax loss harvesting

Tax loss harvesting is selling investments at a loss. The loss will offset gains from other the sale of other securities. Additionally, investors can use $3,000 of investment losses a year to offset ordinary income. They can also carry over any remaining amounts for future tax filings.

 

About the author: Stoyan Panayotov, CFA is a fee-only financial advisor based in Walnut Creek, CA. His firm Babylon Wealth Management offers fiduciary investment management and financial planning services to individuals and families.

Disclaimer: Past performance does not guarantee future performance. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security. The content of this article is a sole opinion of the author and Babylon Wealth Management. The opinion and information provided are only valid at the time of publishing this article. Investing in these asset classes may not be appropriate for your investment portfolio. If you decide to invest in any of the instruments discussed in the posting, you have to consider your risk tolerance, investment objectives, asset allocation and overall financial situation. Different investors have different financial circumstances, and not all recommendations apply to everybody. Seek advice from your investment advisor before proceeding with any investment decisions. Various sources may provide different figures due to variations in methodology and timing. Image Copyright: <a href=’http://www.123rf.com/profile_adamr’>adamr / 123RF Stock Photo</a>